Monday October 8, 2012 - Top 10 Risk Management News

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Monday October 8, 2012 - Top 10 Risk Management News

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Monday October 8, 2012 - Top 10 Risk Management News

  1. 1. Page |1 International Association of Risk and Compliance Professionals (IARCP) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the weeks agenda, and what is next George Lekatis President of the IARCPDear Member,We have some very interesting principles for the supervision offinancial conglomerates.What I really enjoyed:“Supervisors should require that financial conglomerates not make overlyambitious diversification assumptions or imprudent correlation claims,particularly for capital adequacy and solvency purposes”.Also:“While it is possible that the spread of activities within a financialconglomerate may create diversification effects and reduce correlation, itis also true that membership of a financial conglomerate group maycreate “group risks” in the form of financial contagion, reputationalcontagion, ratings contagion (where a subsidiary accesses capitalthrough a parent’s credit rating and then suffers stress following theutilisation of the capital), double/multiple-gearing (use of same capitalmore than once within a group), excessive leveraging (upgrade in thequality of capital as it moves through a group), and regulatory arbitrage.Read more at Number 1Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  2. 2. Page |2Joint Forum, Principles for the supervision offinancial conglomeratesCorporate GovernanceBroadly, corporate governance describes theprocesses, policies and laws that govern how acompany or group is directed, administered orcontrolled.It defines the set of relationships between acompany’s management, its board, itsshareholders, and other recognised stakeholders.Final Basel III Rules inAustraliaAustralian PrudentialRegulation Authority (APRA)To: All locally incorporated authorised deposit-taking institutionsBasel III capital: interim arrangements for Additional Tier 1 and Tier 2capital instrumentsPublic Hearings on the draft factual Report ofthe EU-US Insurance Regulatory DialogueProject _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  3. 3. Page |3Five Questions about the Federal Reserve andMonetary PolicyChairman Ben S. Bernanke, at the Economic Club ofAdoption of UpdatedEDGAR Filer ManualThe Securities andExchange Commission (the Commission) is adopting revisions to theElectronic Data Gathering, Analysis, and Retrieval System (EDGAR)Filer Manual and related rules to reflect updates to the EDGAR system.Dealing with financial systemic risk:the contribution of macroprudentialpoliciesPanel remarks by Jaime Caruana,General Manager of the Bank forInternational Settlements, CentralBank of Turkey/G20 Conference on"Financial systemic risk", Istanbul _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  4. 4. Page |4EU to Gabriel Bernardino (EIOPA)2013 work programmeEuropean Securities and MarketsAuthorityESMA’s key objectives and priorities in 2013 _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  5. 5. Page |5Solvency II – monitoring the ongoingappropriateness of internal modelsJulian Adams, Director, InsuranceIn June 2012 I wrote to all firms in our internalmodel approval process to share our thinking on the way we will monitorthe ongoing appropriateness of internal models after approval.The UK CorporateGovernance CodeImportant partsThe first version of the UK Corporate Governance Code (the Code) wasproduced in 1992 by the Cadbury Committee.Its paragraph 2.5 is still the classic definition of the context of the Code:“Corporate governance is the system by which companies are directedand controlled. Boards of directors are responsible for the governance oftheir companies.The shareholders’ role in governance is to appoint the directors and theauditors and to satisfy themselves that an appropriategovernance structure is in place.The responsibilities of the board include setting the company’s strategicaims, providing the leadership to put them into effect, supervising themanagement of the business and reporting to shareholders on theirstewardship.The board’s actions are subject to laws, regulations and the shareholdersin general meeting.” _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  6. 6. Page |6NUMBER 1Joint Forum, Principles for thesupervision of financial conglomeratesCorporate GovernanceBroadly, corporate governance describes theprocesses, policies and laws that govern how acompany or group is directed, administered orcontrolled.It defines the set of relationships between acompany’s management, its board, itsshareholders, and other recognisedstakeholders.Corporate governance also provides the structure through which theobjectives of the company are set, and the means of attaining thoseobjectives and monitoring performance are determined.Good corporate governance should provide proper incentives for theboard and management to pursue objectives that are in the interests ofthe company and its shareholders and should facilitate effectivemonitoring.The presence of an effective corporate governance system, within anindividual company or group and across an economy as a whole, helps toprovide a degree of confidence that is necessary for the properfunctioning of a market economy.Financial conglomerates are often complex groups with multipleregulated and unregulated financial and other entities.Given this inherent complexity, corporate governance must carefullyconsider and balance the combination of interests of recognisedstakeholders of the ultimate parent, and the regulated financial and otherentities of the group. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  7. 7. Page |7Ensuring that a common strategy supports the desired balance and thatregulated entities are compliant with regulation on an individual and onan aggregate basis should be a goal of the governance system.This governance system is the fiduciary responsibility of the board ofdirectors.When assessing corporate governance across a financial conglomerate,supervisors should apply these principles in a manner that is appropriateto the relevant sectors and the supervisory objectives of those sectors.This section describes the elements of the governance system mostrelevant to financial conglomerates, and how they should be assessed bysupervisors.Corporate governance in financial conglomerates10. Supervisors should seek to ensure that the financial conglomerateestablishes a comprehensive and consistent governance frameworkacross the group that addresses the sound governance of the financialconglomerate, including unregulated entities, without prejudice to thegovernance of individual entities in the group.Implementation criteria10(a) Supervisors should require that the corporate governanceframework of the financial conglomerate has minimum requirements forgood governance of the entities of the financial conglomerate which allowfor the prudential and legal obligations of its constituent entities to beeffectively met.The ultimate responsibility for the sound and prudent management of afinancial conglomerate rests with the board of the head of the financialconglomerate.10(b) Supervisors should require that the financial conglomerateemphasises a high degree of integrity in the conduct of its affairs. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  8. 8. Page |810(c) Supervisors should seek to ensure that the corporate governanceframework appropriately balances the diverging interests of constituententities and the financial conglomerate as a whole.10(d) Supervisors should require that the governance framework respectsthe interests of policy holders and depositors (where relevant), and shouldseek to ensure that it respects the interests of other recognisedstakeholders of the financial conglomerate and the financial soundness ofentities in the financial conglomerate.10(e) Supervisors should require that the governance framework includesadequate policies and processes that enable potential intra-groupconflicts of interest to be avoided, and actual conflicts of interest to beidentified and managed.Explanatory comments10.1 The corporate governance framework should address whereappropriate:• Alignment to the structure of the financial conglomerate;• Financial soundness of the significant owners;• Suitability of board members, senior management and key persons incontrol functions including their ability to make reasonable and impartialbusiness judgments;• Fiduciary responsibilities of the boards of directors and seniormanagement of the head company and material subsidiaries;• Management of conflicts of interest, in particular at the intra-group leveland remuneration policies and practices within the financialconglomerate; and• Internal control and risk management systems and internal audit andcompliance functions for the financial conglomerate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  9. 9. Page |910.2 The group’s corporate governance framework should notably includea strong risk management framework (refer to the Risk Managementsection), a robust internal control system, effective internal audit andcompliance functions, and ensure that the group conducts its affairs withappropriate independence and a high degree of integrity.10.3 Group-wide governance not only involves the governance of the headof the financial conglomerate, but also applies group-wide to all materialactivities and entities of the financial conglomerate.10.4 In the event the local corporate governance requirements applicableto any particular material entity in the financial conglomerate are belowthe group standards, the more stringent group corporate governancestandards should apply, except where this would lead to a violation oflocal law.10.5 Supervisors should require that the corporate governance frameworkof the financial conglomerate includes a code of ethical conduct.10.6 Supervisors should require that the financial conglomerate have inplace policies focused on identifying and managing potential intra-groupconflicts of interest, including those that may result from intra-grouptransactions, charges, up streaming dividends, and risk-shifting.The policies should be approved by the board of the head of the financialconglomerate and be effectively implemented throughout the group.The policies should recognise the long-term interest of the financialconglomerate as a whole, the long term interest of the significant entitiesof the financial conglomerate, the stakeholders within the financialconglomerate, and all applicable laws and regulations.Structure of the financial conglomerate11. Supervisors should seek to ensure that the financial conglomerate hasa transparent organisational and managerial structure, which isconsistent with its overall strategy and risk profile and is well understoodby the board and senior management of the head company. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  10. 10. P a g e | 10Implementation criteria11(a) Supervisors should understand the financial conglomerate’s groupstructure and the impact of any proposed changes to this structure.11(b) Supervisors should assess the ownership structure of the financialconglomerate, including the financial soundness and integrity of itssignificant owners.11(c) Supervisors should seek to ensure that the structure of the financialconglomerate does not impede effective supervision. Supervisors mayseek restructuring under appropriate circumstances to achieve this, ifnecessary.11(d) Supervisors should seek to ensure that the board and seniormanagement of the head of the financial conglomerate are capable ofdescribing and understanding the purpose, structure, strategy, materialoperations, and material risks of the financial conglomerate, includingthose of unregulated entities that are part of the financial conglomeratestructure.11(e) Supervisors should assess and monitor the financial conglomeratesprocess for approving and controlling structural changes, including thecreation of new legal entities.11(f) Where the financial conglomerate is part of a wider group,supervisors should require that the board and senior management of thehead of the financial conglomerate have governance arrangements thatenable material risks stemming from the wider group structure to beidentified and appropriately assessed by relevant supervisory authorities.11(g) Supervisors should seek to ensure that there is a frameworkgoverning information flows within the financial conglomerate andbetween the financial conglomerate and entities of the wider group (egreporting procedures). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  11. 11. P a g e | 11Explanatory comments11.1 A financial conglomerate may freely set its functional, hierarchical,business and/or regional organisation, provided all entities within thefinancial conglomerate comply with their relevant sectoral and legalframeworks.11.2 Elements to be considered for assessing the significant ownershipstructure of the financial conglomerate may include the identification ofsignificant owners, including the ultimate beneficial owners, thetransparency of their ownership structure, their financial information, andthe sources of their initial capital and all other requirements of nationalauthorities.At a minimum, the necessary qualities of significant owners relate to theintegrity demonstrated in personal behaviour and business conduct, aswell as to the ability to provide additional support when needed.11.3 Supervisors should seek to ensure that a financial conglomerate hasan organisational and managerial structure that promotes and enablesprudent management, and if necessary, orderly resolution aligned withcorresponding sectoral requirements.Reporting lines within the financial conglomerate should be clear andshould facilitate information flows within the financial conglomerate,both bottom-up and top-down.11.4 Supervisors should be satisfied that the board and seniormanagement of the head of the financial conglomerate understand andinfluence the evolution of an appropriate group legal structure inalignment with the approved business strategy and risk profile of thefinancial conglomerate, and understand how the various elements of thestructure relate to one another.Where a financial conglomerate creates many legal entities, their numberand, particularly, the interconnections and transactions between them,may pose challenges for the design of effective corporate governancearrangements. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  12. 12. P a g e | 12This risk should be recognised and managed.This is particularly the case where the organisational and managerialstructure of the financial conglomerate deviates from the legal entitystructure of the financial conglomerate.11.5 Supervisors should assess changes to the group structure and howthese changes impact its soundness, especially where such changes causethe financial conglomerate to engage in activities and/or operate injurisdictions that impede transparency or do not meet internationalstandards stemming from sectoral regulation.Suitability of board members, senior managers and key personsin control functions12. Supervisors should seek to ensure that the board members, seniormanagers and key persons in control functions in the various entities in afinancial conglomerate possess integrity, competence, experience andqualifications to fulfil their role and exercise sound objective judgment.Implementation criteria12(a) Supervisors should be satisfied of the suitability of board members,senior managers and key persons in control functions.12(b) Supervisors should require financial conglomerates to havesatisfactory processes for periodically assessing suitability.12(c) Supervisors should require that the members of the boards of thehead of the financial conglomerate and of its significant subsidiaries actindependently of parties and interests external to the wider group; andthat the board of the head of the financial conglomerate include a numberof members acting independently of the wider group (including owners,board members, executives, and staff of the wider group).12(d) Supervisors should communicate with the supervisors of otherregulated entities within the conglomerate when board members, senior _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  13. 13. P a g e | 13management and key persons in control functions are deemed not tomeet their suitability tests.Explanatory comments12.1 Board members, senior managers and key persons in controlfunctions need to have appropriate skills, experience and knowledge, andact with care, honesty and integrity, in order to to make reasonable andimpartial business judgments and strengthen the protection afforded torecognised stakeholders.To this end, institutions need to prudently manage the risk that personsin positions of responsibility may not be suitable.Suitability criteria may vary depending on the degree of influence on orthe responsibilities for the financial conglomerate.12.2 Supervisors of regulated entities of the financial conglomerate aresubject to statutory and other requirements in applying suitability tests tothese entities in their jurisdiction.The organisational and managerial structure of financial conglomeratesadds elements of complexity for supervisors seeking to ensure thesuitability of persons.For instance, the management of regulated entities within the financialconglomerate can be extensively influenced by persons who are notdirectly responsible for such functions.A group-wide perspective regarding suitability of persons is intended toclose any loopholes in this respect.Supervisors may rely on assessments made by other relevant supervisorsin this area regarding suitability.Alternatively they may decide on concerted supervisory actions regardingsuitability if required. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  14. 14. P a g e | 1412.3 In order to meet suitability requirements, board members, seniormanagers and key persons in control functions, both individually andcollectively, should have and demonstrate the ability to perform the dutiesor to carry out the responsibilities required in their position.Competence can generally be judged from the level of professionalism (egpertinent experience within financial industries or other businesses)and/or formal qualifications.12.4 Serving as a board member or senior manager of a company (fromthe wider group) that competes or does business with the regulatedentities in the financial conglomerate can compromise independentjudgment and create conflicts of interest, as can cross-membership onboards.A board’s ability to exercise objective judgment independent of the viewsof executives and of inappropriate political or personal interests can beenhanced by recruiting members from a sufficiently broad population ofcandidates.The key characteristic of independence is the ability to exercise objective,independent judgment after fair consideration of all relevant informationand views without undue influence from executives or from inappropriateexternal parties and interests and while taking into account therequirements of applicable law.Responsibility of the board of the head of the financialconglomerate13. Supervisors should require that the board of the head of the financialconglomerate appropriately defines the strategy and risk appetite of thefinancial conglomerate, and ensures this strategy is implemented andexecuted in the various entities, both regulated and unregulated. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  15. 15. P a g e | 15Implementation criteria13(a) Supervisors should require that the board of the head of the financialconglomerate has in place a framework for monitoring compliance withthe strategy and risk appetite across the financial conglomerate.13(b) Supervisors should require that the board of the head of the financialconglomerate regularly assesses the strategy and risk appetite of thefinancial conglomerate to ensure it remains appropriate as theconglomerate evolved.13(c) Where the financial conglomerate is part of a wider group,supervisors should assess whether the head is managing its relationshipwith the wider group and ultimate parent in a manner that is consistentwith the governance framework of the financial conglomerate.13(d) Supervisors should require that a framework is in place which seeksto ensure resources are available across the financial conglomerate forconstituent entities to meet both the group and their own entity’sgovernance standards.Explanatory comments13.1 Supervisors should assess if the board of directors exercises adequateoversight over the management of the head of the financial conglomerate.This includes assessing the actions taken by the board of the head todefine the strategy for the financial conglomerate and ensure theconsistency of the operations of the various entities in the financialconglomerate with such strategy.To this end, the head company should set up an adequate corporategovernance framework in line with the structure, business and risks of thefinancial conglomerate and its entities and applicable laws.This framework should ensure that the strategy is implemented andmonitored throughout the financial conglomerate and reviewed on a _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  16. 16. P a g e | 16regular basis and following material change including due to growth,increased complexity, geographic expansion, etc.13.2 The head company should exercise adequate oversight ofsubsidiaries, both regulated and unregulated, while respectingindependent legal and governance responsibilities.Supervisors should satisfy themselves that entities within a financialconglomerate adhere to the same group-wide corporate governanceprinciples or at least apply policies that remain consistent with theseprinciples.The board of a regulated subsidiary of a financial conglomerate will retainand set its own corporate governance responsibilities and practices in linewith its own legal requirements or in proportion to its size or business.These should not, however, conflict with the broader financialconglomerate corporate governance framework.Appropriate governance arrangements will address arrangements suchthat legal or regulatory provisions or prudential rules of regulatedsubsidiaries will be known and taken into account by the head company.13.3 Where the financial conglomerate is part of a wider group structure,the head of the financial conglomerate is responsible for managing therelationship with its wider group.This includes ensuring there are appropriate arrangements for capital andliquidity management, assessing any material risk impact that may comefrom decisions made at its ownership level, service level agreements,reporting lines and regular top-level consultations with related companiesin the wider group and the ultimate parent.13.4 For smaller institutions within a larger conglomerate, it may beunnecessary to duplicate systems and controls.Such smaller institutions can rely on the systems and controls of the headif they have assessed that this is suitable to address group risks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  17. 17. P a g e | 1713.5 Supervisors should be satisfied with the amount and quality ofinformation they receive from the head company of the financialconglomerate on its strategy, risk appetite and corporate governanceframework.Remuneration in a financial conglomerate14. Supervisors should require that the financial conglomerate has andimplements an appropriate remuneration policy that is consistent with itsrisk profile. The policy should take into account the material risks thatorganisation is exposed to, including those from its employees’ activities.Implementation criteria14(a) Supervisors should require that an appropriate remuneration policyconsistent with established international standards is in place andobserved at all levels and across jurisdictions in the financialconglomerate.An appropriate policy aligns risk-takers’ variable remuneration withprudent risk taking, promotes sound and effective risk management, andtakes into account any other appropriate factors.The overarching objective of the policy should be consistent across thegroup but can allow for reasonable differences based on the nature of theconstituent entities/units and local legal requirements.14 (b) Supervisors should require that ultimate oversight of theremuneration policy rest with the financial conglomerate’s headcompany.14(c) Supervisors should require that the remuneration of board members,senior managers and key persons in control functions be determined in amanner that does not incentivise them to disregard the obligations theyowe to the financial conglomerate or any of its entities, nor to otherwiseact in a manner contrary to any legal or regulatory obligations. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  18. 18. P a g e | 1814(d) Supervisors should require that the risks associated withremuneration are reflected in the financial conglomerate’s broader riskmanagement framework.For example, staff engaged in financial and risk control at the group-widelevel should be compensated in a manner that is consistent with theircontrol role and should be involved in designing incentive arrangements,and assessing whether such arrangements encourage imprudentrisk-taking.14(e) Supervisors should require that the variable remuneration receivedby risk management and control personnel is not based substantially onthe financial performance of the business units that they review but ratheron the achievement of the objectives of their functions (eg adherence tointernal controls).Explanatory comments14.1 Remuneration is a key aspect of any governance framework andneeds to be properly considered in order to mitigate the risks that mayarise from poorly designed remuneration arrangements.The risks associated with remuneration should be reflected in thefinancial conglomerate’s broader risk management framework.14.2 Remuneration may serve important objectives, including attractingskilled staff, promoting better organisation-wide and employeeperformance, promoting retention, providing retirement security andallowing personnel costs to vary with revenues.It is also clear, however, that ill-designed compensation arrangementscan provide incentives to take risks that are not consistent with the longterm health of the organisation. Such risks and misaligned incentives areof particular supervisory interest.14.3 Ultimately a financial conglomerate’s remuneration policy shouldaim to ensure effective governance of remuneration, alignment of _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  19. 19. P a g e | 19remuneration with prudent risk-taking, and engagement of recognisedstakeholders.14.4 Supervisors should ensure that the governance system identifies andcloses loopholes that allow the circumvention of conglomerate, sectoral orentity-level remuneration requirements.14.5 Board members, senior managers and key persons in controlfunctions should be measured against performance criteria tied not onlyto the short-term, but also to the long-term interest of the financialconglomerate as a whole.V. Risk ManagementSince financial conglomerates are in the business of risk-taking, good riskmanagement is a crucial focus of supervision.This section provides principles for the sound and comprehensivesupervision of risk management frameworks in financial conglomerates.It covers factors ranging from risk culture and tolerance, to the use ofstress and scenario testing and the monitoring of risk concentrations.Risk management framework21. Supervisors should require that an independent, comprehensive andeffective risk management framework, accompanied by a robust systemof internal controls, effective internal audit and compliance functions, isin place for the financial conglomerate.Implementation criteria21(a) Supervisors should ensure that the risk management framework iscomprehensive, consistent across entities supervised in all sectors andcovers the risk management function, risk management processes andgovernance, and systems and controls. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  20. 20. P a g e | 20Risk management function21(b) Supervisors should require that the risk management function isindependent from the business units and has a sufficient level of authorityand adequately skilled resources to carry out its functions.21(c) Supervisors should require that the risk management functiongenerally has a direct reporting line to the board and senior managementof the financial conglomerate.21(d) Supervisors should, where they consider it appropriate, require thata separate risk management committee at the board of directors level isestablished by the financial conglomerate.Risk management governance21(e) Supervisors should require that the board of the head of the financialconglomerate has overall responsibility for the financial conglomerate’sgroup-wide risk management, internal control mechanism, internal auditand compliance functions to ensure that the group conducts its affairswith a high degree of integrity.21(f) Supervisors should require that the financial conglomerate has anestablished enterprise-wide risk management process for, among others,periodically reviewing the effectiveness of the group-wide riskmanagement framework and for ensuring appropriate aggregation ofrisks.21(g) Supervisors should require that the risk management process coveridentification, measurement, monitoring and controlling of risk types (egcredit risk, operational risk, strategic risk, liquidity risk) and these belinked where appropriate to specific capital requirements.Systems and controls21(h) Supervisors should require that financial conglomerates have inplace adequate, sound and effective risk management processes andinternal control mechanisms at the level of the financial conglomerate, _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  21. 21. P a g e | 21including sound administrative and accounting procedures.21(i) Supervisors should require that risk management processes andinternal control mechanisms of a financial conglomerate areappropriately documented and, at a minimum, take into account the:• nature, scale and complexity of its business;• diversity of its operations, including geographical reach ;• volume, frequency and size of its transactions;• degree of risk associated with each area of its operation;• interconnectedness of the entities within the financial conglomerate(using intra-group transactions and exposures reporting as one measure);and• sophistication and functionality of information and reporting systems.Explanatory comments21.1 Financial conglomerates, irrespective of their particular mix ofbusiness lines or financial sectors, are in the business of risk taking.Therefore, strong risk management is of paramount importance.21.2 The comprehensive risk management framework and process shouldinclude board and senior management oversight.21.3 In identifying, evaluating, monitoring, controlling and mitigatingmaterial risks (from regulated and unregulated activities), financialconglomerates should consider the prospect for these to change over timeand prepare themselves accordingly.21.4 The risk management processes and internal control mechanisms ofa financial conglomerate should include clear arrangements fordelegating authority and responsibility; segregation of the functions thatinvolve committing the financial conglomerate’s funds and accounting _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  22. 22. P a g e | 22for assets and liabilities; reconciliation of these processes; safeguarding ofthe financial conglomerate’s assets; and appropriate independent internalaudit and compliance functions to test adherence to these controls as wellas applicable laws and regulations.Risk tolerance levels and risk appetite policy23. Supervisors should require that the financial conglomerate establishesappropriate board approved, group-wide risk tolerance levels and a riskappetite policy.Implementation criteria23(a) Supervisors should require that key staff, senior management andthe board of the head of the financial conglomerate be aware of andunderstand the financial conglomerate’s risk tolerance levels and riskappetite policy.23(b) Supervisors should require that the financial conglomerate identifyand measure against risk tolerance limits (and in line with its risk appetitepolicy) the risk exposure of the financial conglomerate on an on-goingbasis in order to identify potential risks as early as possible.This may include looking at risks by territory, by line of business, or byfinancial sector.Explanatory comments23.1 Financial conglomerates should establish risk tolerance levels and arisk appetite policy which set the tone for acceptable and unacceptablerisk taking.This should be aligned with the financial conglomerate’s businessstrategy, risk profile and capital plan.23.2 A financial conglomerate’s risk tolerance should be kept underperiodic review so as to ensure that it remains relevant and takes accountof the changing dynamics of the financial conglomerate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  23. 23. P a g e | 23The financial conglomerate’s risk appetite policy is re-assessed regularlywith respect to new business opportunities, changes in risk capacity andtolerance, and operating environment.New business24. Supervisors should require that the financial conglomerate carries outa robust risk assessment when entering into new business areas.Implementation criteria24(a) Supervisors should, where they consider it appropriate, review therisk assessment carried out by a financial conglomerate in the context ofentering into new business.24(b) Supervisors should require that financial conglomerates not expandinto new products unless they have put in place adequate processes,controls and systems (such as IT) to manage them.24(c) Supervisors should make sure that a financial conglomerate carriesout the ongoing risk assessment after entering into new business areas.Explanatory comments24.1 At the time of assessing whether or not to enter into a new businessarea or product line, it is imperative that financial conglomeratesundertake risk assessments and analyses to identify potential risksinherent in the new activity.24.2 They should seek to understand the potential interaction between therisks of the new activity and the existing risk profile of the financialconglomerate.This should include a consideration of whether the new activity couldadversely affect the risk appetite or risk tolerance of the financialconglomerate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  24. 24. P a g e | 24Outsourcing25. Supervisors should require that, when considering whether tooutsource a particular function, the financial conglomerate carries out anassessment of the risks of outsourcing, including the appropriateness ofoutsourcing a particular function.Implementation criteria25(a) Supervisors should require that financial conglomerates haveprocesses and criteria in place to review decisions to outsource a functionin order to ensure that such outsourcing does not imply delegation ofresponsibility for that function.25(b) Supervisors should be satisfied that the decision to outsource afunction does not impede effective group-wide supervision of thefinancial conglomerate.Explanatory comments25.1 It is important that supervisors be satisfied that, when consideringwhether to outsource a particular function, financial conglomerates haveconsidered the risks involved and the appropriateness of outsourcing aparticular function.This includes considering the appropriateness of outsourcing to aparticular provider and the cumulative risks of all outsourced functions.The supervisor should require the financial conglomerate to review theprovider in advance to ensure it is in a position to provide the services,comply with the contractual terms, and observe all applicable laws andregulations.25.2 Supervisors should periodically assess the outsourced function withregard to policy compliance, risk management measures and controlprocedures. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  25. 25. P a g e | 2525.3 Outsourcing should never result in a delegation of responsibility for agiven function.There may be certain functions within financial conglomerates whichshould not be outsourced under any circumstances, while there may besome that may only be outsourced if certain safeguards are put in place.Stress and scenario testing26. Supervisors should require, where appropriate, that the financialconglomerate periodically carries out group-wide stress tests andscenario analyses for its major sources of risk.Implementation criteria26(a) Supervisors should require that stress tests are sufficiently severe,forward looking and flexible.They should cover an appropriate set of business activities and include avariety of different types of tests such as sensitivity analyses, scenarioanalyses and reverse stress testing.26(b) Supervisors should require the financial conglomerate to documentits stress and scenario tests, including reverse stress tests.Stress tests should be conducted under a robust governance frameworkthat encompasses policies, procedures, and adequate documentation ofprocedures as well as validation of results.26(c) Supervisors should require that the group-wide stress tests andscenario analyses conducted by the financial conglomerate areappropriate to the nature, scale and complexity of those major sources ofrisk and to the nature, scale and complexity of the financialconglomerate’s business.26(d) Supervisors should require that group-wide stress tests and scenarioanalyses include a group-wide approach (which takes account of the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  26. 26. P a g e | 26interaction between different parts of the group and different risk types)and consider the results of sectoral stress tests.26(e) Supervisors should require that, when carrying out reverse stresstests, a financial conglomerate identifies a range of adversecircumstances which would cause its business to fail and assess thelikelihood of such events crystallising.Explanatory comments26.1 A financial conglomerate should have a good understanding ofcorrelation between its respective sectors and the heterogeneity of suchrisks when conducting its stress tests.Stress tests should be robust and should consider sufficiently adversecircumstances.The group-wide stress test analysis should measure and evaluate thepotential impact on individual entities.26.2 Attention should be paid to covering all risks, including off-balancesheet items.For example, a financial conglomerate’s stress tests and scenario analysesshould take into account the risk that the financial conglomerate mayhave to bring back on to its consolidated balance sheet the assets andliabilities of off-balance sheet entities as a result of reputationalcontagion, notwithstanding the appearance of legal risk transfer.26.3 Where reverse stress tests reveal a risk of business failure that isunacceptably high relative to the financial conglomerate’s risk appetite orrisk tolerance, the financial conglomerate should evaluate and adopt,where appropriate, effective arrangements, processes, systems or othermeasures to prevent or mitigate that risk. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  27. 27. P a g e | 27Risk aggregation27. Supervisors should require that the financial conglomerate aggregatethe risks to which it is exposed in a prudent manner.Implementation criteria27(a) Supervisors should require that financial conglomerates ***notmake overly ambitious diversification assumptions*** or imprudentcorrelation claims, particularly for capital adequacy and solvencypurposes.27(b) Supervisors should require financial conglomerates to haveadequate resources and systems (including IT) for the purpose ofaggregating risks.Explanatory comments27.1 Risk aggregation should include a clear understanding ofassumptions and be robust enough to support a comprehensiveassessment of risk.27.2 While it is possible that the spread of activities within a financialconglomerate may create diversification effects and reduce correlation, itis also true that membership of a financial conglomerate group maycreate “group risks” in the form of financial contagion, reputationalcontagion, ratings contagion (where a subsidiary accesses capitalthrough a parent’s credit rating and then suffers stress following theutilisation of the capital), double/multiple-gearing (use of same capitalmore than once within a group), excessive leveraging (upgrade in thequality of capital as it moves through a group), and regulatory arbitrage(it is important that risks are assessed at the financial conglomerate levelas well as at the level of its constituent parts). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  28. 28. P a g e | 28Risk concentrations and intra-group transactions and exposures28. Supervisors should require that the financial conglomerate has inplace effective systems and processes to manage and report group-widerisk concentrations and intra-group transactions and exposures.Implementation criteria28(a) Supervisors should require that the financial conglomerate has inplace effective systems and processes to identify, assess and reportgroup-wide risk concentrations (including for the purposes of monitoringand controlling those concentrations).28(b) Supervisors should require that the financial conglomerate has inplace effective systems and processes to identify, assess and reportsignificant intra-group transactions and exposures.28(c) Supervisors should require the financial conglomerate to reportsignificant risk concentrations and intra-group transactions andexposures at the level of the financial conglomerate on a regular basis.28(d) Supervisors should consider setting quantitative limits andadequate reporting requirements.Explanatory comments28.1 Supervisors should ensure that financial conglomerates aremanaging their risk concentrations and intra-group transactions andexposures satisfactorily.28.2 Supervisors should encourage adequate public disclosure of riskconcentrations and intra-group transactions and exposures.28.3 Supervisors should liaise closely with one another to ascertain eachother’s concerns and coordinate as deemed appropriate any supervisoryaction relative to risk concentrations and intra-group transactions andexposures within the financial conglomerate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  29. 29. P a g e | 2928.4 Supervisors should deal effectively with material risk concentrationsand intra-group transactions and exposures that are considered to have adetrimental effect on the regulated entities or the financial conglomerateas a whole.Off-balance sheet activities29. Supervisors should require that off-balance sheet activities, includingspecial purpose entities, are brought within the scope of group-widesupervision of the financial conglomerate, where appropriate.Implementation criteria29(a) Supervisors should require that there is a process for determiningwhether the nature of the relationship between the financial conglomerateand a special purpose entity (SPE) requires the SPE to be fully orproportionally consolidated into the financial conglomerate for regulatorypurposes.29(b) Supervisors should require that the financial conglomerate’s stresstests and scenario analyses take into account the risk associated with offbalance sheet activities.29(c) Supervisors should require that the overall nature of the relationshipbetween the financial conglomerate and the SPE is considered includingthe risk of contagion from the SPE. This assessment should go beyondtraditional control and influence relationships.Explanatory comments29.1 A financial conglomerate’s risk management framework andprocesses should cover the full spectrum of risks to the financialconglomerate. This includes risks from regulated and unregulatedentities, including SPEs and off-balance sheet activities.29.2 The fact that a financial conglomerate does not own or control theSPE in the traditional sense should not mean that it should not beconsolidated.Other channels of contagion should be considered, such as the provisionof (actual or contingent) liquidity support, reputational risk, and whether _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  30. 30. P a g e | 30the assets of the SPE previously belonged to the financial conglomerateor were third-party assets.29.3 It is important that financial conglomerates assess all economic risksand business purposes of an SPE throughout the life of a transaction,distinguishing between risk transfer and risk transformation.Financial conglomerates should be particularly aware that, over time, thenature of these risks can change.Supervisors should require such assessment to be ongoing and thatmanagement has sufficient understanding of the risks.29.4 Financial conglomerates should have the capability to aggregate,assess and report all their SPE exposure risks in conjunction with all otherfirm-wide risks.29.5 Supervisors should regularly oversee and monitor the use of all SPEactivity and assess the implications for the financial conglomerate of theactivities of SPEs, in order to identify developments that can lead tosystemic weakness and contagion or that can exacerbate pro-cyclicality. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  31. 31. P a g e | 31NUMBER 2Final Basel III Rules inAustraliaAustralian PrudentialRegulation Authority(APRA)To: All locally incorporated authorised deposit-taking institutionsBasel III capital: interim arrangements for Additional Tier 1 and Tier 2capital instrumentsAPRA has released final prudential standards implementing the Basel IIImeasures to raise the quality, consistency and transparency of the capitalbase, including Prudential Standard APS 111 Capital Adequacy:Measurement of Capital (APS 111).This letter sets out APRA’s treatment of new Additional Tier 1 and Tier 2capital instruments issued before the new standard comes into effect on +To be eligible for inclusion in regulatory capital, all capital instrumentsthat have not been submitted to APRA for review before close of businesstoday must comply with the final version of APS 111 issued today.Instruments that have been submitted to APRA up to and includingtoday’s date and that were intended to be issued under the currenttransitional arrangements (including APRA’s letters to industry dated 27May 2011 and 30 March 2012), will be assessed against these criteria.To be counted as eligible regulatory capital, instruments approved byAPRA under these criteria must be issued before close of business on 31December 2012.Any questions in relation to this letter should in the first instance bedirected to your Responsible Supervisor.Yours sincerelyCharles LittrellExecutive General Manager _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  32. 32. P a g e | 32NotesIn December 2010, the Basel Committee on Banking Supervision (BaselCommittee) released a package of reforms to raise the level and quality ofregulatory capital in the global banking system (Basel III).APRA is a member of the Basel Committee and fully supports theimplementation of these reforms.In September 2011, APRA released a discussion paper outlining itsproposals to implement these Basel III capital reforms in Australia.APRA subsequently released, in March and June 2012, draft prudentialand reporting standards on which submissions were invited.In June 2012, APRA also invited submissions on its proposal that certaincapital instruments be subject to Australian law and on its proposedregulatory capital treatment of joint arrangements.Fifteen submissions were received on the March and June 2012consultation packages.APRA’s capital adequacy prudential and reporting standardsSubmissions were broadly supportive of the content of the draftprudential and reporting standards and mostly sought clarification ofparticular provisions.In response, APRA has:• clarified its expectations for an ADI’s Internal Capital AdequacyAssessment Process (ICAAP), which are included in the draft PrudentialPractice Guide CPG 110 Internal Capital Adequacy AssessmentProcess and supervisory review (CPG 110) recently released for publicconsultation;• revised its proposed treatment of an ADI’s funding of purchases of itsown capital instruments, including margin loans; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  33. 33. P a g e | 33• removed the ‘profits test’ from Additional Tier 1 and Tier 2 Capitalinstruments;• clarified the operation of the countercyclical capital buffer;• simplified transitional arrangements for capital issued by consolidatedsubsidiaries and held by third parties; and• made minor changes to the prudential and reporting standards toimprove ease of use.Submissions raised concerns about APRA’s proposal that certain capitalinstruments should be subject to Australian law.APRA acknowledges these concerns.In response, it has clarified areas of uncertainty about the loss absorptionand non-viability requirements and has refined its approach to thequestion of governing law for capital instruments, such that only thoseprovisions of capital instrument documentation dealing with lossabsorption and non-viability must be governed by Australian law.In June 2012, the Basel Committee finalised its proposals to improveconsistency and ease of use of disclosures on capital positions and capitalcomposition.These measures, which are to come into effect for reporting periodsending on or after 30 June 2013, include a common template anddisclosure provisions that, if implemented, would facilitate comparisonbetween the capital position of banking institutions across jurisdictions.APRA will consult in early 2013 on these requirements.Consultation with industry and other interested stakeholders _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  34. 34. P a g e | 34The Basel III reforms also implement measures relating to external creditassessment institutions (ECAIs) and to minimise cliff effects arising fromguarantees and derivatives.Objectives and key requirements of this Prudential StandardThis Prudential Standard requires an authorised deposit-takinginstitution (ADI) to maintain adequate capital, on both a Level 1 andLevel 2 basis, to act as a buffer against the risk associated with itsactivities.The ultimate responsibility for the prudent management of capital ofan ADI rests with its Board of directors.The Board must ensure the ADI maintains an appropriate level andquality of capital commensurate with the type, amount andconcentration of risks to which the ADI is exposed.The key requirements of this Prudential Standard are that an ADIand any Level 2 group must:- have an Internal Capital Adequacy Assessment Process;- maintain required levels of regulatory capital;- operate a capital conservation buffer and, if required, a countercyclical capital buffer;- inform APRA of any adverse change in actual or anticipated capital adequacy; and- seek APRA’s approval for any planned capital reductions.Interesting:An ADI that is part of a group may rely on the ICAAP of the groupprovided that the Board of the ADI is satisfied that the group ICAAPmeets the criteria in respect of the ADI. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  35. 35. P a g e | 35Group risk management8. Paragraphs 9 to 13 of this Prudential Standard apply to an ADI thatheads a conglomerate group.Where an ADI is part of a conglomerate group headed by an authorisednon-operating holding company (authorised NOHC), the requirementsset out in paragraphs 9 to 13 of this Prudential Standard apply to the ADIand its subsidiaries.9. For conglomerate groups headed by an ADI, the Board of the ADI isresponsible for ensuring that comprehensive policies and procedures arein place to measure, manage, monitor and report overall risk at a grouplevel.To ensure that existing Board-approved policies and the relevant controlsremain adequate and appropriate for managing and monitoring overallgroup risk, the Board or a board committee must review them regularly(at least annually) to take account of changing risk profiles of groupentities.Any material changes to group risk management policies must beapproved by the Board.10. The Board of an ADI must ensure that the ADI establishesappropriate policies, systems and procedures to monitor compliance withAPRA’s prudential requirements on a group basis.To facilitate conglomerate group supervision by APRA, an ADI must:(a) provide APRA with the following group information:(i) details of group members (e.g. name, place of incorporation, boardcomposition, nature of business and any other additional informationrequired by APRA for a better understanding of the risk profiles ofindividual group members); _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  36. 36. P a g e | 36(ii) management structure of the group (including key risk managementreporting lines);(iii) intra-group support arrangements (e.g. a specific guarantee of theobligations of an entity in the group);(iv) intra-group exposures; and(v) other information as required by APRA from time to time for theeffective supervision of the group;(b) notify APRA in accordance with section 62A of the Banking Act of anybreach of a requirement in a prudential standard or a condition of abanking authority (whether by an ADI in the group or by the group) andof any circumstances that might reasonably be seen as having a materialimpact and potentially adverse consequences for an ADI in the group orfor the overall group;(c) advise APRA in advance of any proposed changes to the compositionor operations of the group with the potential to materially alter the group’soverall risk profile (this must include any proposed changes to the ADI’sstand-alone operations); and(d) obtain APRA’s prior written approval for the establishment oracquisition of a regulated presence domestically or overseas.11. An ADI must provide APRA with descriptions of its group riskmanagement policies and the procedures used to measure and controloverall group risk (including any material changes thereto).The ADI should, as best practice, disclose in the group’s full publishedannual report each year an outline of its group risk management policies,including the policies governing dealings between the ADI and othergroup members.12. An ADI must submit a declaration signed by its chief executive officer,approved by the Board, covering the Level 2 groups risk managementsystems within three months of the ADIs annual balance date in _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  37. 37. P a g e | 37accordance with the declaration requirements in Prudential Standard APS310 Audit and Related Matters (APS 310).13. If an ADI qualifies the declaration in paragraph 12, the ADI mustexplain the reasons for the qualifications in accordance with therequirements in APS 310 and provide plans for corrective action. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  38. 38. P a g e | 38NUMBER 316 October 2012 - Public Hearingson the draft factual Report of theEU-US Insurance RegulatoryDialogue ProjectThe EU-US Insurance RegulatoryDialogue Project organises two publichearings on the draft factual Reportbased on the results of the Project’s seventechnical committees (TC).The public hearings will take place:In the USA: on 12 October 2012 at 14.00 – 17.00 hrs EDT in the GrandHyatt, Washington DC;In Belgium: on 16 October 2012 at 10.00 – 13.00 hrs CET in the Centre deConférences Albert Borschette, Brussels.Requests to provide oral statements during the public hearings should besent by 10 October 2012 to the following email addresses:tom.finnell{at}treasury.gov (Washington Hearing) andManuela.Zweimueller{at}eiopa.europa.eu (Brussels Hearing). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  39. 39. P a g e | 39The EU-US Dialogue ProjectThe EU-US Dialogue Project started in early 2012, when the EuropeanCommission (EC), EIOPA, the US National Association of InsuranceCommissioners (NAIC) and the Federal Insurance Office of the USDepartment of the Treasury (FIO) agreed to participate in dialogue and arelated project (Project) to contribute to an increased mutualunderstanding and enhanced cooperation between the European Unionand the United States to promote business opportunity, consumerprotection and effective supervision.The objective of the Project, which builds on more than a decade ofEU-US regulatory dialogue, is to deepen insight into the overall design,function and objectives of the key aspects of the insurance supervisoryregimes in the EU and the U.S, and to identify important characteristicsof both regimes.Request for the EU-U.S. Dialogue Project for Public Commenton the Technical Committee ReportsComparing Certain Aspects of the Insurance Supervisory andRegulatory Regimes in the European Union and the UnitedStatesTo Interested Parties:The Steering Committee of the EU-U.S. Dialogue Project invites publiccomment on the reports of seven technical committees comparing certainaspects of the insurance supervisory regimes in the European Union andthe United States. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  40. 40. P a g e | 40Introduction to the EU-U.S. Dialogue ProjectIn the EU, the European Parliament, the Council of the European Unionand the European Commission (EC), technically supported by theEuropean Insurance and Occupational Pensions Authority (EIOPA), aremodernizing the EU’s insurance regulatory and supervisory regimethrough the Solvency II Directive (Directive 2009/138/EC), in place since2009.This so-called Framework Directive was the culmination of work begunin the 1990s to update existing solvency standards in the EU.Current work aims to further specify the Framework Directive withtechnical rules and guidelines, which are necessary for a consistentapplication by insurers and supervisors of the framework.In the United States, the states are the primary regulators of the insuranceindustry.State insurance regulators are members of the National Association ofInsurance Commissioners (NAIC), a standard-setting and regulatorysupport organization created and governed by the chief insuranceregulators from the 50 states, the District of Columbia and five U.S.territories.As part of an evolutionary process, through the NAIC, state insuranceregulators in the U.S. are currently in the process of enhancing theirsolvency framework through the Solvency Modernization Initiative(SMI). SMI is an assessment of the U.S. insurance solvency regulationframework and includes a review of international developments regardinginsurance supervision, banking supervision, and international accountingstandards and their potential use in U.S. insurance regulation.In early 2012, the EC, EIOPA, the NAIC and the Federal Insurance Officeof the U.S. Department of the Treasury (FIO) agreed to participate indialogue and a related project (Project) to contribute to an increased _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  41. 41. P a g e | 41mutual understanding and enhanced cooperation between the EU andthe U.S. to promote business opportunity, consumer protection andeffective supervision.The project is considered to be part of and builds on the on-going EU-USDialogue which has been in place for over 10 years.The work is carried out in collaboration with EIOPA and competentauthorities in the EU Member States, and with state insurance regulatorsand the NAIC in the United States.The objective of the Project is to deepen insight into the overall design,function and objectives of the key aspects the two regimes, and to identifyimportant characteristics of both regimes.Project Governance and Process: The Project is led by a six-memberSteering Committee comprised of three EU and three U.S. officials, asfollows:• Gabriel Bernardino – Chairman of EIOPA• Edward Forshaw – Manager in the Prudential Policy division, UKFinancial Services Authority, and EIOPA Equivalence Committee Chair• Karel Van Hulle – Head of Unit for Insurance and Pensions,Directorate-General Internal Market and Services, EC• Kevin M. McCarty– Commissioner, Office of Insurance Regulation,State of Florida, and current President of the NAIC• Michael McRaith – Director, FIO, United States Department of theTreasury• Therese M. (Terri) Vaughan – Chief Executive Officer, NAICSince the Project began, the Steering Committee has held severalface-to-face meetings in Basel, Washington DC and Frankfurt, as well asnumerous conference calls. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  42. 42. P a g e | 42In a first step, the topics to be discussed were agreed upon and a processfor information exchange under confidentiality obligations wasestablished.The Steering Committee agreed upon seven topics fundamentallyimportant to a sound regulatory regime and to the protection ofpolicyholders and financial stability.The seven topics are:• Professional secrecy/confidentiality;• Group supervision;• Solvency and capital requirements;• Reinsurance and collateral requirements;• Supervisory reporting, data collection and analysis;• Supervisory peer reviews; and• Independent third party review and supervisory on-site inspections.A separate Technical Committee (TC) was assembled to address eachtopic.Each TC was comprised of experienced professionals from both theEuropean Union as well as the United States, specifically, from FIO, theEC, the NAIC and EIOPA, as well as representatives from state insuranceregulatory agencies in the United States and competent authorities of EUMember States.The various professionals who comprised the technical committees wereselected because of their qualifications and experience with respect to thesubject matter of each topic, including insurance regulators andsupervisors, attorneys, accountants, examiners, and other specialists.The teams worked jointly to develop objective, fact-based reportsintended to summarize the key commonalities and differences betweenthe Solvency II regime in the EU, and the state-based insuranceregulatory regime in the United States. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  43. 43. P a g e | 43Supporting documentation, e.g., regulations, directives, and supervisoryguidance, was exchanged as requested by either side.The accompanying seven technical committee reports have been jointlydrafted and reflect the consensus views of each respective technicalcommittee’s members.No action has been taken by the governing bodies of the organizationsrepresented on the Steering Committee to formally adopt the draft factualreports and thus this document should not be considered to expressofficial views or positions of any organization.The reports represent the culmination of the initial work from the firstphase of the Project.The reports are being exposed for interested party analysis and commentand will inform discussions and conclusions reached by the SteeringCommittee on each topic during the second phase of the Project.It is envisaged that the second phase of the Project will involvediscussions of the Steering Committee about the key commonalities anddifferences between the two regimes and will lead to policy decisions bytheir respective organizations regarding whether and how to achievefurther harmonization in regulation and supervision.The project is scheduled to come to a conclusion by December 31, 2012. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  44. 44. P a g e | 44 _____________________________________________________________International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  45. 45. P a g e | 45The Contributing PartiesThe Federal Insurance Office, U.S. Department of the TreasuryThe Federal Insurance Office (FIO) of the U.S. Department of theTreasury was established by the Dodd-Frank Wall Street Reform andConsumer Protection Act.The FIO monitors all aspects of the insurance industry, includingidentifying issues or gaps in the regulation of insurers that couldcontribute to a systemic crisis in the insurance industry or the UnitedStates financial system.The FIO serves on the U.S. Financial Stability Oversight Council.The FIO coordinates and develops U.S. Federal policy on prudentialaspects of international insurance matters, including representing theUnited States, as appropriate, in the International Association ofInsurance Supervisors.The FIO assists the Secretary in negotiating certain internationalagreements, and serves as the primary source for insurance sectorexpertise within the Federal government.The FIO monitors access to affordable insurance by traditionallyunderserved communities and consumers, minorities, and low- andmoderate-income persons.The FIO also assists the Secretary in administering the Terrorism RiskInsurance Program.The European CommissionThe European Commission (EC) is one of the main institutions of theEuropean Union. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  46. 46. P a g e | 46It represents and upholds the interests of the EU as a whole. The EC isthe executive branch of the EU and is responsible for proposing newEuropean laws to Parliament and the Council.The EC oversees and implements EU policies by enforcing EU law(together with the Court of Justice), and represents the EUinternationally, for example, by negotiating international tradeagreements between the EU and other countries.It also manages the EUs budget and allocates funding.The 27 Commissioners, one from each EU country, provide theCommission’s political leadership during their 5-year term.The National Association of Insurance CommissionersThe National Association of Insurance Commissioners (NAIC) is thestandard-setting and regulatory support organization created andgoverned by the chief insurance regulators from the 50 states, the Districtof Columbia and five U.S. territories.Through the NAIC, state insurance regulators establish standards andbest practices, conduct peer review, and coordinate their regulatoryoversight that is exercised at the state level.NAIC staff supports these efforts and represents the collective views ofstate regulators domestically and internationally.NAIC members, together with the central resources of the NAIC, formthe national regime of state-based insurance regulation in the UnitedStates.European Insurance and Occupational Pensions AuthorityThe European Insurance and Occupational Pensions Authority (EIOPA)was established as a result of the reforms to the structure of supervision ofthe financial sector in the European Union. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  47. 47. P a g e | 47The reform was initiated by the EC, following the recommendations of aCommittee of Wise Men, chaired by Mr. de Larosière, and supported bythe European Council and Parliament.EIOPA technically supports the EC, amongst others, in themodernization of the EU’s insurance regulatory and supervisory regime.Current work aims to further specify the Solvency II Framework Directivewith technical rules and guidelines, which is necessary for a consistentapplication by insurers and supervisors of the framework. In cross-bordersituations, EIOPA also has a legally binding mediation role to resolvedisputes between competent authorities and may make supervisorydecisions directly applicable to the institution concerned.EIOPA is part of the European System of Financial Supervisionconsisting of three European supervisory authorities, the others being thenational supervisory authorities and the European Systemic Risk Board.EIOPA is an independent advisory body to the EC, the EuropeanParliament and the Council of the European Union.EIOPA’s core responsibilities are to support the stability of the financialsystem, transparency of markets and financial products as well as theprotection of insurance policyholders, pension scheme members andbeneficiaries. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  48. 48. P a g e | 48NUMBER 4Five Questions about the Federal Reserve andMonetary PolicyChairman Ben S. Bernanke, at the Economic Club ofIndiana, Indianapolis, IndianaGood afternoon. I am pleased to be able to join the Economic Club ofIndiana for lunch today.I note that the mission of the club is "to promote an interest in, andenlighten its membership on, important governmental, economic andsocial issues." I hope my remarks today will meet that standard.Before diving in, Id like to thank my former colleague at the WhiteHouse, Al Hubbard, for helping to make this event possible.As the head of the National Economic Council under President Bush, Alhad the difficult task of making sure that diverse perspectives oneconomic policy issues were given a fair hearing before recommendationswent to the President.Al had to be a combination of economist, political guru, diplomat, andtraffic cop, and he handled it with great skill.My topic today is "Five Questions about the Federal Reserve andMonetary Policy."I have used a question-and-answer format in talks before, and I knowfrom much experience that people are eager to know more about theFederal Reserve, what we do, and why we do it.And that interest is even broader than one might think.Im a baseball fan, and I was excited to be invited to a recent battingpractice of the playoff-bound Washington Nationals.I was introduced to one of the teams star players, but before I could pressmy questions on some fine points of baseball strategy, he asked, "So,whats the scoop on quantitative easing?" _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  49. 49. P a g e | 49So, for that player, for club members and guests here today, and foranyone else curious about the Federal Reserve and monetary policy, I willask and answer these five questions:What are the Feds objectives, and how is it trying to meet them?Whats the relationship between the Feds monetary policy and the fiscaldecisions of the Administration and the Congress? What is the risk that the Feds accommodative monetary policy will leadto inflation?How does the Feds monetary policy affect savers and investors?How is the Federal Reserve held accountable in our democratic society?What Are the Feds Objectives, and How Is It Trying to MeetThem? The first question on my list concerns the Federal Reserves objectivesand the tools it has to try to meet them. As the nations central bank, the Federal Reserve is charged withpromoting a healthy economy--broadly speaking, an economy with lowunemployment, low and stable inflation, and a financial system thatmeets the economys needs for credit and other services and that is notitself a source of instability.We pursue these goals through a variety of means. Together with otherfederal supervisory agencies, we oversee banks and other financialinstitutions.We monitor the financial system as a whole for possible risks to itsstability.We encourage financial and economic literacy, promote equal access tocredit, and advance local economic development by working withcommunities, nonprofit organizations, and others around the country.We also provide some basic services to the financial sector--for example,by processing payments and distributing currency and coin to banks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  50. 50. P a g e | 50But today I want to focus on a role that is particularly identified with theFederal Reserve--the making of monetary policy.The goals of monetary policy--maximum employment and pricestability--are given to us by the Congress.These goals mean, basically, that we would like to see as many Americansas possible who want jobs to have jobs, and that we aim to keep the rate ofincrease in consumer prices low and stable.In normal circumstances, the Federal Reserve implements monetarypolicy through its influence on short-term interest rates, which in turnaffect other interest rates and asset prices.Generally, if economic weakness is the primary concern, the Fed acts toreduce interest rates, which supports the economy by inducingbusinesses to invest more in new capital goods and by leadinghouseholds to spend more on houses, autos, and other goods andservices.Likewise, if the economy is overheating, the Fed can raise interest rates tohelp cool total demand and constrain inflationary pressures.Following this standard approach, the Fed cut short-term interest ratesrapidly during the financial crisis, reducing them to nearly zero by the endof 2008--a time when the economy was contracting sharply.At that point, however, we faced a real challenge: Once at zero, theshort-term interest rate could not be cut further, so our traditional policytool for dealing with economic weakness was no longer available.Yet, with unemployment soaring, the economy and job market clearlyneeded more support.Central banks around the world found themselves in a similarpredicament.We asked ourselves, "What do we do now?"To answer this question, we could draw on the experience of Japan,where short-term interest rates have been near zero for many years, aswell as a good deal of academic work. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  51. 51. P a g e | 51Unable to reduce short-term interest rates further, we looked instead forways to influence longer-term interest rates, which remained well abovezero.We reasoned that, as with traditional monetary policy, bringing downlonger-term rates should support economic growth and employment bylowering the cost of borrowing to buy homes and cars or to finance capitalinvestments.Since 2008, weve used two types of less-traditional monetary policy toolsto bring down longer-term rates. The first of these less-traditional tools involves the Fed purchasinglonger-term securities on the open market--principally Treasurysecurities and mortgage-backed securities guaranteed bygovernment-sponsored enterprises such as Fannie Mae and Freddie Mac.The Feds purchases reduce the amount of longer-term securities held byinvestors and put downward pressure on the interest rates on thosesecurities.That downward pressure transmits to a wide range of interest rates thatindividuals and businesses pay.For example, when the Fed first announced purchases ofmortgage-backed securities in late 2008, 30-year mortgage interest ratesaveraged a little above 6percent; today they average about 3-1/2 percent.Lower mortgage rates are one reason for the improvement we have beenseeing in the housing market, which in turn is benefiting the economymore broadly.Other important interest rates, such as corporate bond rates and rates onauto loans, have also come down.Lower interest rates also put upward pressure on the prices of assets, suchas stocks and homes, providing further impetus to household andbusiness spending.The second monetary policy tool we have been using involvescommunicating our expectations for how long the short-term interest ratewill remain exceptionally low. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  52. 52. P a g e | 52Because the yield on, say, a five-year security embeds marketexpectations for the course of short-term rates over the next five years,convincing investors that we will keep the short-term rate low for a longertime can help to pull down market-determined longer-term rates.In sum, the Feds basic strategy for strengthening the economy--reducinginterest rates and easing financial conditions more generally--is the sameas it has always been.The difference is that, with the short-term interest rate nearly at zero, wehave shifted to tools aimed at reducing longer-term interest rates moredirectly.Last month, my colleagues and I used both tools--securities purchasesand communications about our future actions--in a coordinated way tofurther support the recovery and the job market.Why did we act? Though the economy has been growing since mid-2009and we expect it to continue to expand, it simply has not been growingfast enough recently to make significant progress in bringing downunemployment.At 8.1 percent, the unemployment rate is nearly unchanged since thebeginning of the year and is well above normal levels.While unemployment has been stubbornly high, our economy hasenjoyed broad price stability for some time, and we expect inflation toremain low for the foreseeable future.So the case seemed clear to most of my colleagues that we could do moreto assist economic growth and the job market without compromising ourgoal of price stability.Specifically, what did we do? On securities purchases, we announced thatwe would buy mortgage-backed securities guaranteed by thegovernment-sponsored enterprises at a rate of $40 billion per month.Those purchases, along with the continuation of a previous programinvolving Treasury securities, mean we are buying $85 billion oflonger-term securities per month through the end of the year. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  53. 53. P a g e | 53We expect these purchases to put further downward pressure onlonger-term interest rates, including mortgage rates.To underline the Federal Reserves commitment to fostering asustainable economic recovery, we said that we would continue securitiespurchases and employ other policy tools until the outlook for the jobmarket improves substantially in a context of price stability.In the category of communications policy, we also extended our estimateof how long we expect to keep the short-term interest rate at exceptionallylow levels to at least mid-2015.That doesnt mean that we expect the economy to be weak through 2015.Rather, our message was that, so long as price stability is preserved, wewill take care not to raise rates prematurely.Specifically, we expect that a highly accommodative stance of monetarypolicy will remain appropriate for a considerable time after the economystrengthens.We hope that, by clarifying our expectations about future policy, we canprovide individuals, families, businesses, and financial markets greaterconfidence about the Federal Reserves commitment to promoting asustainable recovery and that, as a result, they will become more willingto invest, hire and spend.Now, as I have said many times, monetary policy is no panacea.It can be used to support stronger economic growth in situations inwhich, as today, the economy is not making full use of its resources, and itcan foster a healthier economy in the longer term by maintaining low andstable inflation.However, many other steps could be taken to strengthen our economyover time, such as putting the federal budget on a sustainable path,reforming the tax code, improving our educational system, supportingtechnological innovation, and expanding international trade.Although monetary policy cannot cure the economys ills, particularly intodays challenging circumstances, we do think it can provide meaningfulhelp. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  54. 54. P a g e | 54So we at the Federal Reserve are going to do what we can do and trust thatothers, in both the public and private sectors, will do what they can aswell.Whats the Relationship between Monetary Policy and FiscalPolicy?That brings me to the second question: Whats the relationship betweenmonetary policy and fiscal policy?To answer this question, it may help to begin with the more basicquestion of how monetary and fiscal policy differ. In short, monetary policy and fiscal policy involve quite different sets ofactors, decisions, and tools.Fiscal policy involves decisions about how much the government shouldspend, how much it should tax, and how much it should borrow.At the federal level, those decisions are made by the Administration andthe Congress.Fiscal policy determines the size of the federal budget deficit, which is thedifference between federal spending and revenues in a year.Borrowing to finance budget deficits increases the governments totaloutstanding debt.As I have discussed, monetary policy is the responsibility of the FederalReserve--or, more specifically, the Federal Open Market Committee,which includes members of the Federal Reserves Board of Governorsand presidents of Federal Reserve Banks.Unlike fiscal policy, monetary policy does not involve any taxation,transfer payments, or purchases of goods and services. Instead, as Imentioned, monetary policy mainly involves the purchase and sale ofsecurities.The securities that the Fed purchases in the conduct of monetary policyare held in our portfolio and earn interest. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  55. 55. P a g e | 55The great bulk of these interest earnings is sent to the Treasury, therebyhelping reduce the government deficit.In the past three years, the Fed remitted $200 billion to the federalgovernment.Ultimately, the securities held by the Fed will mature or will be sold backinto the market. So the odds are high that the purchase programs that theFed has undertaken in support of the recovery will end up reducing, notincreasing, the federal debt, both through the interest earnings we sendthe Treasury and because a stronger economy tends to lead to higher taxrevenues and reduced government spending (on unemployment benefits,for example).Even though our activities are likely to result in a lower national debt overthe long term, I sometimes hear the complaint that the Federal Reserve isenabling bad fiscal policy by keeping interest rates very low and therebymaking it cheaper for the federal government to borrow.I find this argument unpersuasive.The responsibility for fiscal policy lies squarely with the Administrationand the Congress.At the Federal Reserve, we implement policy to promote maximumemployment and price stability, as the law under which we operaterequires.Using monetary policy to try to influence the political debate on thebudget would be highly inappropriate.For what its worth, I think the strategy would also likely be ineffective:Suppose, notwithstanding our legal mandate, the Federal Reserve were toraise interest rates for the purpose of making it more expensive for thegovernment to borrow.Such an action would substantially increase the deficit, not only becauseof higher interest rates, but also because the weaker recovery that wouldresult from premature monetary tightening would further widen the gapbetween spending and revenues. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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